Most investors – I’m talking about institutional mutual fund managers, buy-and-hold investors, diversified investors, everyday investors – are deathly afraid of crazy volatility.
But not me. And not the biggest baddest, richest hedge fund managers in the world, not investment bank trading desks at Goldman Sachs or Morgan Stanley or Deutsche Bank.
We’re not deathly afraid. We’re thrilled to death because we make money from volatility.
The thing is, we know how to make crazy money from crazy volatility. We live for it.
Now you’re going to learn to love volatility because I’m going to tell you exactly how to make boatloads of money off all the volatility we’re going to experience this year.
First, let me tell you what’s causing the volatility.
Then, I’ll show you how it can make you rich…
This Volatility Began With The Fed
It will ebb and flow all year. There’ll be weeks at a time when things will calm down, then seemingly out of nowhere they’ll get crazy again. It’s going to be that kind of year.
The root cause of volatility we’re facing is the Federal Reserve’s zero interest rate policy (or ZIRP, for short).
ZIRP was, is, and will be madness.
I say “was” because it’s already been tried. I say “is” because we’re dealing with its implications now. And I say “will be” because the Fed’s wrong about the recovery they think they see.
ZIRP was the Fed’s desperate play to lower interest rates to zero so big banks could borrow for nothing and use the proceeds to buy low interest rate-paying U.S. Treasuries.
In the process the U.S. Treasury got to issue tons of debt at low rates to keep funding the country’s growing deficits. Big banks got to make huge profits via the risk-free return they made borrowing at zero and collecting interest on Treasuries they bought, which the Fed bought from them to multiply their profits exponentially.
The whole insane idea was that low rates would trickle down to consumers who would borrow and spend to get the economy going again.
That didn’t quite happen.
What happened is most of the excess money and credit created by the Fed’s policies was taken advantage of by big-scale borrowers who actually could borrow cheaply. They were banks who also trade and corporations who could borrow to buy back their shares, lift their stock prices, and make their earnings look good (buybacks reduces shares outstanding, which makes earnings per share metrics a lot better). That brought in sidelined investors who thought we were out of the woods and markets were safe.
After all, if you can’t make anything on your savings account, if bonds don’t pay squat, you have to risk going into stocks to get some return if you want to retire.
Not surprisingly, manipulation distorted markets as capital flowed – not into productive capital expenditures (capex) or infrastructure building, mind you – but into stock buying sprees.
Central banks everywhere followed the Fed down the rabbit hole.
Of course stocks soared. Bond prices soared, so much so that some countries sovereign bonds have negative yields! And commodity prices soared… for a while.
The Cracks Are Starting to Show
Commodities were the first asset class to tumble. Cheap money flooded into oil and energy capex and into mining capex, until overproduction led to oversupply, stockpiling, and imploding oil and ore and metals prices.
Stocks are now facing that paradigm shift. And bonds will be right behind them.
Now, when nervous investors look at commodities markets, stock markets and bond markets, they’re seeing how gross distortions led to bubbles everywhere.
That’s the basis of volatility. But it’s only the tip of an upside-down iceberg.
Markets are facing geopolitical headwinds, which is a polite way of saying craziness.
Russia is fighting in Ukraine and in Syria where they may face off against U.S. and European interests. Russia’s also facing down Turkey and stirring up trouble elsewhere in the Middle East by backing both Sunnis and Shiites fighting each other. Saudi Arabia is facing off against Iran. Sectarian fighting is engulfing the whole Middle East and threatening regimes across the region. No one knows how heated it will get.
That’s adding exponentially to volatility.
China’s economy is on the brink of imploding. The little engine that could – and did – carry the world on the heels of the 2008 credit crisis is faltering. If China can’t prevent its economy from slipping, if the Chinese yuan crashes in currency markets, all hell will break loose across global markets.
That’s adding exponentially to volatility.
Then there are the other volatility-creating beasts roaming the investing landscape.
Cybersecurity threats, diverging central bank policy prescriptions, sovereign wealth funds liquidating assets to meet budget shortfalls, huge carry trades being unwound globally, deflationary trends picking up steam, unsustainable public debts, ISIS incursions, global terrorism threats, negative bond yields, backsliding economies in Europe, questions about European unity, Brazil in a free fall, looming currency wars, and black swans circling that no one can see but investors fear are out there somewhere.
All that’s adding exponentially to volatility.
And I’m not even getting into the brass tacks of the markets. Like how only a handful of momentum stocks took the markets up since last August’s swoon, which by the way was caused by China devaluing the yuan less than 2%. Or how 40% of stocks are trading below their 200-day moving averages. Or how high-frequency trading has reduced liquidity and made markets prone to 1000-point drops. Or how more regulations on banks is sidelining them and further reducing liquidity. Or how corporate profits have peaked and are heading south. Or how more than $3 trillion in buybacks is about to go up in smoke. Or… shall I go on? Because I can.
But you get it. Everything the markets are facing creates volatility, and there’s so much they’re facing that volatility is becoming “layered” on top of itself.
The last time global markets faced this much volatility was in 2008. But his time around, the volatility factors are much more diversified and fundamental on top of technical issues facing stocks, bonds, and every asset class.
Preparing Yourself for Volatile Markets
Volatility in 2016 is going to be insane.
So much money can be made off volatility it staggers the mind.
Crazy volatility means huge price swings, both down and up. Over and over.
To make money you first have to protect what you have invested, so you don’t lose it. The best way to do that is with stop-loss orders.
We just put down stop-losses on all our long positions in my Capital Wave Forecast service.
We’re doing the same at my Short-Side Fortunes service, but we’re mostly short the market already. And about to get a lot shorter.
After you’re protected on the downside on your existing positions, it’s time to put on a bunch of defensive plays that will make a ton of money when markets fall out of bed.
I’m talking about buying put options or outright shorting. I recommend shorting stocks near their all-time highs. If the market turns back around, which it could do because it’s getting “oversold,” cover those shorts if they make new highs. If the market keeps going down, add to your short positions.
When markets fall and you’re making money on your shorts or on the puts you’re buying, I strongly recommend taking big profits when you get them, like we do.
We’ll be booking profits and ringing the register when we have big gains from falling stocks because we’ll then be buying big selloffs to ride the inevitable bounces higher when markets become grossly oversold.
As a trader I never worry about leaving profits on the table. If I’m making a ton of money getting the big up and down moves right, I don’t care about squeezing out all the profits.
That’s a loser’s game. The way to make money when there’s crazy volatility is to ride the big moves and take your profits fairly quickly when you’re sitting pretty so you can calmly (and with a pocketful of cash) get back in going the opposite direction.
The luxury of trading extreme volatility is you can enter positions close to the bottom of a move, or close to the top of a move, and not have to catch the exact top or bottom. In other words, trading tops and bottoms of big moves actually becomes less risky, not more risky.
Whenever I’m positioning for a turn in the market near a top or bottom, I give my new positions about 5% to 10% swing room to go against me. If I get a 10% loss, unless I’m more convinced and am willing to add to my position because I “know” the turn is coming (and sometimes I know), I’ll get out with a small loss so I can calmly assess the market before making another move.
Make Money on Volatility with These Instruments
Another way to make money when volatility is extreme is by actually trading volatility.
I like buying the iPath S&P 500 Volatility Short Term Futures ETN (NYSEArca:VXX) and buying calls on the VIX (which are actually calls on the VIX short-term futures) when I’m expecting a spike in volatility.
These are short-term holds. If you’re right, you should ride a directional move up in volatility as long as it’s obvious. As soon as you’re not sure, or better yet, if you’ve got a quick, fat profit, take you gains quickly. You can make windfall profits if you get in and out and capture the majority of a move that lasts just a few days.
And because volatility goes both ways, once it’s spiked it usually falls, sometimes very quickly as investors exhale and go to the sidelines to figure out their next moves, I like shorting volatility (betting volatility will subside) after a big volatility spike.
You can do that by buying puts on the VIX, or by buying inverse volatility ETFs and ETNs like VelocityShares Daily Inverse VIX MT ETN (NYSEArca:ZIV), VelocityShares Daily Inverse VIX ST ETN (NYSEArca:XIV), and ProShares Short VIX Short-Term Futures (NYSEArca:SVXY).
Buying and selling volatility as a combined strategy – meaning buying volatility when you expect it to rise and selling it when you expect it to subside – is called a “reversion to the mean” trade.
The VIX generally trades in a fairly narrow range, so buying it when you expect it to go up and then betting it will revert to its “mean” or average trading range makes sense, and lots of hedge funds and big traders trade the VIX that way.
Last, but certainly not least, all the volatility we’re going to see in 2016 isn’t just going to impact stocks. Every asset class will experience extreme volatility in 2016.
We’re going to trade every asset class all year in my newsletter services because volatility is going to mean making money in 2016. And it will be the easiest it’s been in a long time.